Following the launch of the WisdomTree CBOE Russell 2000 PutWrite Strategy Fund on the Cboe BZX US Equities Exchange earlier this month, SRP spoke to Gaurav Sinha, WisdomTree asset allocation strategist, to discuss the new strategy, and how moving away from traditional smart beta strategies can help investors who are overweight US small-cap stocks, to increase potential risk reduction and downside protection via index strategies aimed at lowering volatility without increasing stock-specific risk over time.

Investors often want to ride the upward wave while minimizing the unexpected, according to Sinha. "The WisdomTree CBOE Russell 2000 PutWrite Strategy Fund (RPUT) has been designed to act as a shock-absorber in an investment portfolio, partially protecting from shocks on the downside," said Sinha, pointing that this kind of strategy is very relevant in the current market environment because the S&P 500 has been on an upward trend over the last nine to ten years. "From history, we know that whatever goes up also come down. From an asset allocation standpoint, there is scope for options selling strategies within the ETF world."

There are a number of active funds and structured products using this kind of strategy but they are massively overpriced - a typical active option writing mutual fund could cost the end investor over 100bps, according to Sinha.

The structured products market has seen a number of active strategies including Put Write (ALPS Enhanced Put Write Strategy ETF) and BuyWrite indices (NYSE Enhanced Buy-Write Index, Eurostoxx50 BuyWrite 100% Index) over the years albeit with marginal usage.

SRP data also shows that there are 11 products featuring BuyWrite strategies across markets of which two are still live products: The UBS Capped Bonus Notes - S&P500 Buyback, a structured note linked to the CBOE Buywrite Monthly Index, and the UBS Open End Perles, a continuous play linked to the UBS Evolution Buy-Write Europe Index.

For the new ETF, WisdomTree partnered with Cboe because "it is the main options exchange in the world, and the Cboe Russell 2000 PutWrite Index offered what we were looking for". The index tracks the value of a cash-secured, collateralized put write strategy, which consists of selling Russell 2000 Index put options and holding cash equivalent to maximum possible hypothetical losses in one-month Treasury bills.

Full colateralisation

By selling a put option, the fund receives a premium from the options buyer, which increases the fund's return if the option is not exercised and expires out of the money, according to Sinha. The number of put options sold is chosen to ensure full collateralisation, meaning the total value of the Treasury account must be equal to the maximum possible loss from the final settlement of the put options at expiration.

"The key element of the index is that in an upward trending market, you don't have any losses and simply keep your premiums from selling options, therefore having positive returns," said Sinha. "However, if the market goes down, those premiums will provide you with a cushion and partially absorb losses. Thus, this strategy could also serve as a complement to either an equity allocation or within an alternatives sleeve in an investor's portfolio. We think the simplicity of this product is one of its advantages."

Investors sometimes think of treasuries and fixed income as a proxy for risk reduction but research shows that treasuries are not always negatively correlated to equities, according to Sinha. "We believe this kind of put write strategy offers the protection investors need as the index can react to a sudden market move as a result of an interest rate hike, for instance," said Sinha. "Investor demand for small-cap equities has increased, but they need to be cautious. Small-cap stocks can be a source of outperformance over longer periods of time, but can also lead to a higher beta as they tend to be particularly volatile on the downside. This index gave us the opportunity to offer participation on the upside, but has the mechanisms to limit the impact in a downwards market."

The firm's forecast for 2018 is bullish on equities as "a globally synced recovery is now a reality", but at the same time the ETF provider believes the bull run is now reaching its peak in many asset classes and a hike in interest rates could have a very negative impact on equity markets as the free money being poured into the equities market could dry up very quickly, according to Sinha.

"We are not in the business of timing the market," said Sinha. "Investors should continue to invest in the market, but be mindful that the market is probably in its late stages of a bull run and volatility may occur."

WisdomTree has had a couple of "very good years" particularly in the smart beta and alternatives space, according to Sinha.

"We want to leverage our capabilities to offer strategies that can protect investors from market moves," said Sinha. "Our factor-based products have delivered returns to investors. The focus going forward will be to continue providing products that make sense and are performance-proven."

The Russell 2000 Index measures the performance of the small-cap segment of the US equity universe. The Russell 2000 is a subset of the Russell 3000 Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership.

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